On Monday, March 30, 2009, the Supreme Court heard oral arguments in Travelers Indemnity Company v. Bailey (08-295, 08-307). The issue to be decided is whether a bankruptcy court may enjoin actions against third-party non-debtors. The outcome promises to be relevant in dealing with mass tort liabilities in bankruptcy proceedings.

In 1986, Manhattan federal bankruptcy court issued a landmark reorganization plan that discharged Johns-Manville Corporation and its indemnity insurers from future asbestos-related liability (“Manville Confirmation Order”). In exchange for the release, Travelers Indemnity and other insurers paid their maximum policy coverage to a trust, called the Manville Personal Injury Settlement Trust (“Trust”). Based on the bankruptcy court’s reorganization plan, all claims that were “based upon, arose out of, or related to” Manville’s liability insurance policies were to be directed against the Trust.

The Trust had several advantages. The company could isolate asbestos litigation because all asbestos claims were brought against the Trust. Also, insurers, like Travelers Indemnity, were protected from future suits involving asbestos claims in exchange for funding the Trust. Finally, the Trust allows asbestos plaintiffs to recover regardless of whether the company had any assets at they time they brought their lawsuit because their claims were satisfied by the Trust’s property.

The Manville reorganization plan is considered a huge success and received Congressional approval in 1994. Section 524 of the Bankruptcy Code codified the order and authorizes bankruptcy courts to issue injunctions barring derivative claims against third party insurers. See 11 U.S.C. § 524(g).

Asbestos plaintiffs’ attorneys began testing new theories of liability in 2001. They filed claims against insurance companies, which have come to be known as “direct action” claims, asserting independent theories of liability. The direct action claims against Travelers Indemnity allege the insurance company is liable because it suppressed information about the dangers of asbestos, influenced Manville’s failure to disclose these dangers, violated alleged duties to disclose information about asbestos, and engaged in a conspiracy to conceal pertinent facts about Manville’s products.

In 2002, Travelers Indemnity asked the bankruptcy court to enjoin the direct action claims. Around the same time, Travelers Indemnity engaged in settlement discussions with several of the direct action plaintiffs. Until this point, Chubb Insurance was not involved in asbestos litigation, but was concerned about the settlement discussions. If the bankruptcy court approved the Travelers Indemnity settlement with direct action plaintiffs, Chubb Insurance could be precluded from suing Travelers in cases in which they shared liability. Thus, Chubb Insurance sided with plaintiffs in arguing the bankruptcy court lacked the power to enjoin suits brought against third-party non-debtors.

The bankruptcy court disagreed with Chubb Insurance and the direct action asbestos plaintiffs. The court found the direct actions “arose out of” and “related to” the Manville insurance policies and thus were barred by the original Manville Confirmation Order. The district court agreed.

The Second Circuit reversed, finding the bankruptcy court did not have jurisdiction to enjoin claims brought against Travelers Indemnity, a third-party non-debtor, solely on the basis of Travelers Indemnity’s contribution to the debtor’s estate. The Second Circuit further held that a bankruptcy court only has jurisdiction to enjoin third-party non-debtor claims that directly affect the property of the bankruptcy estate.

Travelers Indemnity appealed and the Supreme Court granted certiorari. The petitioner takes the position that the bankruptcy court’s jurisdiction cannot be limited to the property of the debtor’s estate. Travelers Indemnity further argues that the Second Circuit’s ruling undermines the policy of finality and repose and that allowing independent actions to survive will expose the insurance company to limitless litigation.

The direct action plaintiffs and Chubb Insurance argue that the bankruptcy court’s jurisdiction does not extend beyond the debtor-creditor relations. Moreover, finality and repose are not undermined in this case, because this is merely an attempt by Travelers Indemnity to expand on the scope of the 1986 Manville Confirmation Order.

From the start of oral arguments, Justice Stevens called this a “mysterious case.” He explained that he “can’t figure out what anybody expects to collect from Travelers for what they did. The fact that they defended [Johns-Manville] was proper for them as an insurance company.” See Transcript of Record at 12:16-19, Travelers v. Bailey (argued March 30, 2009) (No. 08-295, 08-307) available here. Yet, at the same time, Justice Stevens seemed to disagree with the idea that the bankruptcy court should be able to enjoin actions that do not affect the bankruptcy debtor’s estate. See Transcript of Record at 11:15-25, 12:1-14.

Chief Justice Roberts and Justice Scalia took particular interest in the breadth of the bankruptcy court’s jurisdiction and made several inquiries regarding the bankruptcy court’s authority to enjoin actions against third-party non-debtors. Similarly, Justice Beyer disfavored a bright line rule where bankruptcy courts could never enjoin actions against third-party non-debtors. See Transcript of Record at 39:8-13.

On the other hand, Justice Souter and Justice Ginsburg addressed practical considerations. Both seem to acknowledge the reality that the Manville insurers would likely have refused a settlement agreement in which hundreds of millions of dollars were contributed to the trust and yet exposure to liability for future claims continued. See Transcript of Record at 34:10-21. Justice Souter went further to ask counsel for the claimants whether the Court should construe the original Manville Confirmation Order bearing that premise in mind.

Justice Breyer pointed out that the impact of the direct action claims will not only reach third-party non-debtors, but will also extend to future debtors. He contends future debtors will be negatively affected because insurance companies will loathe defending future mass tort liability, like asbestos cases. See Transcript of Record at 27:24-25, 28:1-2, 4-10.

Justice Breyer returned to public policy considerations at the end of the argument when he invited counsel to comment on the public policy concerns underlying a decision that would narrow the bankruptcy court’s powers to enforce Manville Confirmation Orders. See Transcript of Record at 53:6-15. Justice Beyer expressed concern over the consequences of failing to channel claims against trusts created in Manville-like reorganizations that preserve assets from which future plaintiffs recover. Without establishing trusts under these reorganizations, company assets are quickly drained through litigation, leaving future plaintiffs with no remedy.

Monday’s oral argument hardly makes predicting the Court’s decision an easy task. It seems, however, the Court will attempt to strike a balance between defining reasonable jurisdictional limits for bankruptcy courts and preserving Manville-like confirmation orders that invite settlement trusts to serve the interests of future claimants and third-party non-debtors alike. As the Manville Confirmation Order has been codified in the Bankruptcy Code and mimicked in various other mass tort claims, this decision will have serious implications for insurers of mass tort liabilities in bankruptcy proceedings.